Recording Your Revenues – The Basics of Sales Transactions
There is one thing all sales transactions have in common: a credit entry to the sales account. The rest depends on the particular circumstances sur- rounding the transaction, and there can be a lot of variation in those circumstances.
Remember, companies with inventory generally must use the accrual method of accounting. Even if your business sells a combination of goods and services, the inventory issue is the deciding factor. That means every sale—even if a sale doesn’t involve any inventory—has to be recorded, whether or not you’ve been paid yet.
For instance, the way your company makes sales has an impact on your transactions. Sales can be made for cash, resulting in a debit to cash; or on credit, resulting in a debit to accounts receivable. Then there’s the “when” factor to consider: companies using the cash method record sales only when actual cash is received, whereas companies using the accrual method record sales in the moment regardless of payment. Finally, your inventory method plays a part in transactions as well. If your company uses a perpetual inventory system, every entry for a product sale must have a corresponding entry for cost of goods sold. Under a periodic inventory system, though, no cost of goods entries are recorded during the accounting period, resulting in a single-entry sales transaction.
The method variables (inventory system and accounting method) are stable factors. Once you’ve chosen a method, it dictates that part of the entry every time. For example, if you use the cash method, you cannot ever record a sales transaction until you’ve been paid. Under a perpetual inventory system, you have to book a cost of goods transaction for every single inventory item you sell. The cash or credit issue may vary, because it depends on the actual sales transactions.
Cash or Credit
There are two major differences between cash sales and credit sales: timing and risk. With a cash sale, you get paid on the spot with currency, checks, or credit cards; with credit sales (where your company extends the credit), you get a promise that your company will be paid some time in the future. Cash sales provide different levels of risk, ranging from none for actual cash to possible risk for credit card sales and customer checks. With credit sales, you run the risk that the customer won’t pay on time or that he won’t pay at all.
In either case, when you complete a sale you need to keep a record of it. With a cash sale, the standard source document (where you can ﬁnd the details of the transaction) is the sales receipt, which contains such information as the date, amount, and description of what was sold. For credit sales (not credit card sales; those are treated like cash sales), the source document is an invoice. Invoices include all the same information as sales receipts, plus a bit more, such as:
- Customer name and contact information
- Customer account number
- Credit terms and due date
- Customer’s purchase order number (where applicable)
- Invoice number
To keep your records straight, use prenumbered sales receipts and invoices, and use them in order. That makes for much easier tracking, both now and down the line.
Cash or Accrual Method
Companies using the cash method of accounting record sales only when cash has been received. Companies using the accrual method of accounting record sales when they take place; the cash part requires a second journal entry at the time of receipt. This doesn’t mean that cash-method companies can’t have credit sales, or that accrual method companies can’t have cash sales; these transactions happen all the time, and they get slightly special treatment. The accounting method dictates only when you count the revenue, not how you got it.
While you’ll want to keep track of every transaction, the accounting method tells you when to book the journal entry. It may seem unimportant whether you record a transaction now or four weeks from now, but some- times that timing can make a very big difference. Take year-end, for example: Under the accrual method, you have to report all the income you earned for the year to the IRS and pay tax on it whether or not you’ve gotten the money.
Using the cash method, though, you have to report and pay tax only on the cash you’ve actually received. A $2,500 sale made on credit on December 31 counts as this year’s taxable income under the accrual method, but not under the cash method.
Periodic or Perpetual Inventory
Inventory adds an extra layer of complication to accounting in general; it’s much easier to do the accounting for a service business than a product- based one. At the most basic level, inventory may add extra journal entries to your sales transactions. Here’s the theory: With the perpetual inventory method, you write a journal entry every time inventory items are bought or sold; with the periodic method, you don’t. Practically speaking, though, you want to keep close track of your inventory for dozens of reasons, some much more important than journal entries.
For your own peace of mind, use a perpetual inventory system only if you’re using accounting software or have very limited inventory. This system isn’t terribly complicated to do manually, but it is extremely time-consuming. Unless you have only one or two inventory items that are incredibly easy to track, go periodic or go computerized.
From an accounting perspective, the difference between the two methods comes down to how many journal entries come with each sales trans- action. With periodic inventory, you make no entry at the time of sale, so there’s just the sales side of the transaction. With perpetual inventory, two journal entries are required every time you sell a product: one to record the sale, and one to move the product out of inventory.